A home loan – sometimes called a mortgage – is simply a long-term loan. You get one through a bank, credit union or other financial institution. Although it is likely to be the biggest loan you ever have, it is designed to be paid off slowly through manageable monthly or fortnightly repayments.
You choose how long you need to pay off the loan. Terms of 30, 25 and 20 years are most common. The lender will use your house as collateral against the loan.
How a home loan works
A home loan is made up of principal and interest. Principal is the amount you borrow. Interest is what you pay to borrow the money. At the start of the loan, your repayments largely consist of interest, with a small amount going towards the principal. As you reduce the principal, your interest charges fall until eventually the loan is paid off.
Our Home Loan Calculator is a quick easy way to see what the repayments will be for a given amount and loan term.
Types of Home Loans
The two most common home loans are variable rate home loans and fixed rate home loans, although there are more home loan types.
Variable Rate Home Loans track movements in the official cash rate, which is set by the central bank, the Reserve Bank of Australia. If the official cash rate goes up, all things being equal so does the interest rate on your loan, along with your repayments. The flip side of the coin is that you save money if the RBA cuts rates. You can ride the swings and roundabouts of interest rate movements.
With Fixed Rate Home Loans, you choose a term usually one, three or five years over which the interest rate will remain the same, regardless. You might do that because you think interest rates are going to rise or because you need some certainty about your repayments perhaps because youre borrowing to the maximum. However, if you lock into a fixed mortgage and rates fall, you’ll miss out on the lower rate.
Traditionally, fixed-rate loans don’t offer the same flexibility or features as variable ones. Many variable loans offer redraw facilities, for instance. A redraw facility allows you to make additional repayments on your mortgage, with access to the funds if you need the money back later.
Its a useful facility, but bear in mind that its usually only available on standard variable-rate loans, which are about 1 percentage point more expensive than basic variable loans. And there may be a minimum amount you have to redraw and a fee.
A way to take advantage of the features offered by the two types of home loan is to split your mortgage; often called a Slit Rate Home Loan, putting half on a fixed rate and half on variable-rate terms. Check your lender doesn’t charge you twice for a Split Mortgage though you dont want to pay two sets of establishment fees and two sets of ongoing fees.
Be aware, too, that therell be a difference between the rate on a fixed loan and that on a variable loan the security of a fixed rate often comes at the cost of a higher rate.
Honeymoon Rate Home Loans
Many lenders offer honeymoon rates. The rates on these loans can be significantly lower than the prevailing variable interest rate. But they last only a limited time usually six to 12 months then the loan reverts to the standard variable rate.
Its not a good deal if the short-term gain of the honeymoon rate is outweighed by higher interest costs over the full term of the loan. Do your sums and make your repayments in those early months at the level theyd be if the standard interest rate applied, by using the Honeymoon Rate Calculator.